Good Governance, Not High Interest Rates is the Key to Economic Recovery

We receive with great relief the news that as of 26 May 2000 the Bangko Sentral ng Pilipinas (BSP) will keep its overnight borrowing and lending rates steady.

Nonetheless, we call on the BSP to reverse its earlier decision to increase interest rates by a full percentage point, in its attempt to stem the further depreciation of the peso.

Why this call? It is because the lack of confidence in the economy
arises from the Estrada administration’s weak, incoherent governance–rather than purely economic reasons. The escalation of the Mindanao conflict, and the spate of bombings underline this crisis of governance. The tensions have long been simmering, with the administration already beleaguered by attacks against cronyism and corruption. Thus the interest-rate cure, an economic measure, cannot address these problems, for they are political questions.

It is therefore no surprise that despite the two rounds of increases in the BSP’s overnight borrowing rates, the peso has slid and the exchange rate continues to fluctuate. The BSP should have learned its lessons from the financial crisis in 1997-98. That is, when market confidence is shaken, not even a jacking up of interest rates would prevent people from shifting to dollar-denominated assets or transferring their liquid assets abroad. Moreover, higher interest rates would further impede investments, growth and employment.

Standard theory states that policymakers increase interest rates to tame inflation, cool down an overheating economy, and temper “irrational exuberance.” This is the reason why the US Federal Reserve has increased interest rates. But the Philippine case is very different: Inflation remains low, growth is barely recovering, and “animal spirits” are weak.

Even the most recent hike in US interest rates is not enough justification for the BSP to jack up interest rates by 100 basis points. Internal factors such as growth and inflation should be the main determinants of interest-rate policy.

The increase in overnight borrowing rates–reaching the double-digit level and hence creating a psychological stir–would exert upward pressure on Treasury bill rates. We are nevertheless confident that the National Treasury–as demonstrated by its track record–will reject any unreasonably high bids.

We, too, are relieved that the BSP has put the brakes on interest rate increases. The BSP has shown some flexibility lately, even showing critics that it can keep the exchange rate competitive through the purchase of dollars in the Philippine Dealing System.

Obviously the volatility of the exchange rate has gone beyond the realm of economic policy. It is but a manifestation of the growing concern in the Philippines and abroad that Estrada’s governance has gone haywire. Only by resolving the governance issue and implementing the needed economic and political reforms can confidence in the Philippine economy be regained.